Bank of America (BAC) has had a great run year-to-date, and after the recent correction/consolidation in the markets, there is a good chance that it's upcoming earnings on April 19, 2012 will provide a catalyst for an upward move.
Fundamentally, bank balance sheets are sound. To be honest there has been little change to their overall assets and liabilities from 6 months ago when bank stocks were at their lows, but the perception of banks being risky has changed, and that is all the market cares about. As long as banks continue to avoid daily negative headlines, and manage to pull off decent earnings beats then the march higher should continue.
Some other fundamental factors support the argument for a continued run in financials, and the market overall:
- The dollar index is starting to look weak again (UUP). A weaker dollar generally causes U.S. markets to rise.
- Yields on treasuries are starting to rise again after the recent equities sell off, which signals more investors are moving out of bonds, and (most likely) moving into equities to capture higher returns ( Higher yields could force the Fed to flood market with dollars by buying bonds to drive down interest rates, this will contribute to a weaker dollar and push more money into equities.)
- TIP Securities (TIP) continue to outperform Intermediate Term Treasuries (IEF). This is signaling a rise in inflation expectations which will provide continued to support to the markets in the future.
Nothing is a sure thing when investing, especially when investing in the big banks. With the European debt-crisis rearing its ugly head recently, there is a chance that the U.S. stock markets will turn sharply downwards. Due to the fact that financials led the downward spiral at the height of the Eurozone crisis last year, it is probable that any sustained downward move will probably be led by financials.
There is also a chance that bank earnings take a turn for the worse, and completely miss estimates. This would most likely lead to a sell-off in financials.
Potential Play on Bank of America Earnings
Let's take a look at a chart of Bank of America (BAC) YTD:
(click to enlarge)
As you can see BAC hit heavy resistance several times around the $10 range, and then fell back to the 50 DMA (and lower BB band) and found some support. It is currently trading around $9/share. It looks like $9 is the near term resistance and once BAC busts through that we will be on our way to the $10 mark. I will be targeting a move within this range for an earnings play.
Bull Call Spread
If you are bullish on Bank of America going into earnings I would recommend using a short term bull call spread to capitalize on a potential upward move:
- Buy the May 2012 $9 calls for $.52
- Sell the May 2012 $10 calls for $.19
- This will give you a net debit of $.33/option ($33 outlay/contract)
- Break-even point is at $9.33
- Max-Profit is $.67/option ($67 gain/contract), at any point when BAC is at or above $10
"Why the May calls?" - I chose the May calls because it gives you a little wiggle room. Just in case the trade doesn't work out immediately you have time for the position to turn profitable, and if you decide to sell the options will have some time value left.
"Why sell the $10 calls, and buy the $9 ones?" - Since Bank of America hit heavy resistance at $10 previously I don't expect the stock to go much higher than that within a month. I recommend buying the $9 May calls because they are at the money, and right now $9 is looking to turn into a support level.
"Why use a spread, and not just a naked call position?" - A standalone call position would give me a profit potential of infinity, but it would cost almost double the spread investment, and since $10 seems to be heavy resistance for BAC there doesn't look to be much profit potential the closer it gets to $10.
This is only one way to play Bank of America's upcoming earnings, but it is a minimal investment play with high profit potential. Please due your own due diligence before investing. Be careful out there.
Additional disclosure: Will use strategy discussed in article.